macrocephalopod

But what this argument is missing is the portfolio effect. Tail risk hedges are inversely correlated with the performance of risk assets and produce outsized returns during times of crisis.

As a result, if tail risk hedges are added to a long-term, regularly rebalanced portfolio, they can cushion drawdowns and mitigate the mechanical reduction of risk asset exposure during times of stress.

In doing so, they can enhance the long-term compound rate of return of the overall investment program, **despite the hedges themselves losing money over long periods of time on a stand-alone basis**.

Some people find this counterintuitive at first. How can adding a money-losing strategy to a portfolio cause that portfolio to make more money over time?

Intuitively, it is because the outsized performance of a tail hedge during large market drawdowns allows a regularly rebalanced portfolio to have more dollar exposure to risky assets in the periods immediately following those large market drawdowns.